What We (Don’t) Know

“Within infinite myths lies the eternal truth, who sees it all? Varuna has but a thousand eyes, Indra but a hundred, you and I, but two.” ~ Devdutt Pattanaik

“Accepting that you don’t know — and can’t know — what the future holds should be liberating, not frustrating.” ~ Jason Zweig

I was recently reading an old post by Jason Zweig titled I Don’t Know, and I Don’t Care.

Jason wrote about –

How he graduated from not believing in indexing and instead picking sector funds and small cap funds,

And then realizing that he was not good at fund-picking and that beating the market was amazingly hard,

And then starting to invest in index funds that he said liberated him from the feeling that he needed to forecast what the market was about to do,

And that gave him more time and mental energy for the important things in life.

If I were to chart out my own life as an investor, I am still at the first stage as described by Jason above. In fact, about six years back, I wrote about my reasons for not investing in index funds as I believed well-managed, low-cost, actively managed funds were a better bet for investors.

In fact, with a view to testing my hypothesis, I started a SIP in HDFC Index Fund’s Sensex Plan alongside a couple of active funds – Quantum Long Term Equity Value Fund and Parag Parikh Long Term Equity Fund (Note: These are not recommendations, but purely examples).

As I check the returns over the past five years, the index fund has generated CAGR of 11.4% (underperforming even the index, owing to tracking error and asset management expenses), even as the funds from Quantum and PPFAS have generated 14.4% and 16.8% respectively.

Now, my facts suffer from survivorship bias as there may be hundreds of other active funds that would have underperformed this index fund over these five years. And thus, investing in an index fund may still be a good idea for someone Warren Buffett called a “know-nothing” investor in his 1993 letter to shareholders. (see the bottom of this post)

The irony, however, is that it is almost impossible to find an investor who fits this bill these days. Where are the “know-nothing” investors, after all?

If you are reading this post, then you live with the fundamental belief that you are God’s gift to mankind. Fret not, because so do I. If not God’s ‘greatest’ gift to mankind, at least God’s ‘above-average’ gift to mankind.

Why else would you choose not to traverse the easy path of buying an index fund; but instead choose to match your wits with millions of other above-average God’s gift to mankind denizens?

The alpha in us is wired so deeply that conscious recognition of this trait is of no use curbing our instinct and drive towards proving ourselves to be God’s gift.

Now, without doubt, I consider myself as one of these God’s gifts to mankind, given that while I continue to listen to Buffett in most things investing, I am yet to take his advice on index funds.

One reason, of course, is that, as compared to the western world, index investing in India has miles to go – in terms of the way index funds are created here, and their costs – to be relevant for investors who know something (I arrogantly believe I am in this camp).

And the second, and a more important reason for me to continue doing what I do now i.e., active investing, is that I have devised my investing process in such a way that it allows me what Jason talked about in the fourth point above i.e., how I invest gives me a lot of time and mental energy for the important things in life.

What I have learned is that whether you are investing via index funds or picking your own stocks, one, you should be doing what you enjoy doing, and two, it should give you ample time to pursue other important things in life.

Now, when I look back at my journey over the past fifteen years, I realize that the most important element of my investment process was not related to what I knew, but what I didn’t.

At almost all points in time, I’ve had more than 80% of my money invested in stocks directly (rest have been in equity funds, provident fund, and little cash). And I have done decently over the years, with all my ups and downs, and despite keeping myself away from “often hot” sectors like BFSI, pharma, commodities, petrochemicals, realty, etc. and other stuff like day trading and derivatives.

Among many things, I just don’t understand the basics of futures and options or how to do special situations. I can’t tell you the difference between a Muthoot and a Manappuram. Specialty chemicals don’t excite me as they bring back memories of my school days when I hated Chemistry as a subject. I cannot differentiate between Phase 1 and 2 trials that pharma companies get involved in. ANDAs and APIs have always been aliens to me, and so have been NIM and MTM. I have no idea when a commodity cycle would turn for the good or bad. I have no special capabilities in spotting turnarounds. And I am pretty bad at predicting, especially the future.

I am fine saying no to and losing opportunities in things I don’t understand, because I have learned to avoid the regrets of missing such opportunities that never belonged to me in the first place.

I still make mistakes in things I think I understand, but that’s perfectly fine because I know I own such mistakes and know whom to blame for them (myself!).

Coming back to the post Jason wrote, he added something very important in an edit in 2015 –

Accepting that you don’t know — and can’t know — what the future holds should be liberating, not frustrating. But you must also not care that you don’t know. If not being able to know the financial future bothers you, then you will never be at peace with your ignorance, and you will live your investing life as a perpetual chase after the unobtainable.

Seeing the panicky investors in BFSI and mid and small cap stocks all around, I cannot help but thank Jason enough for writing the above.

The sad reality of being a stock market investor – for most people – is that we rarely accept that we don’t know — and can’t know — what the future holds. Despite this, we live our investing lives, like Jason wrote, “as a perpetual chase after the unobtainable.”

Here, I am not trying to belittle those who have lost their hard-earned savings betting on bad, risky businesses. Losing money is terrible, it’s painful, and especially when you are not sure whom to blame – yourself, or the companies that turned out duds, or the financial industry and advisors that sold you those duds.

However, experience has taught me that my investing life would not be incomplete if I don’t ever understand or own businesses that are difficult to understand for me (and thus I won’t understand their risks too), or are not worth investing at all.

I have seen people learn this lesson the hard way. But acting within the circle of what’s easy to know for you (with great probability) and what you know of that is a good idea. It may be a small circle, but that should not worry you. Crossing its boundaries, must.

After all, the mark of a person on the path to wisdom is that he knows that he knows nothing. He would rather be a seeker than a learned, and that’s what keeps him on the path.

Addendum: Warren Buffett on index investing in his 1993 letter – “…situation requiring wide diversification occurs when an investor who does not understand the economics of specific businesses nevertheless believes it in his interest to be a long-term owner of American industry. That investor should both own a large number of equities and space out his purchases. By periodically investing in an index fund, for example, the know-nothing investor can actually out-perform most investment professionals. Paradoxically, when “dumb” money acknowledges its limitations, it ceases to be dumb.”

Reader Interactions

Comments

Key Lesson – Need to add a lot more of honesty, integrity and humility to my investing process.

We may assume we are very humble, but especially in active investing (where it looks so easy to make money) – one has to assume that one is above average. Since the aim is to make money, and make money quickly – we can game/fool ourselves by getting into what is really “A price trade” (where we feel we can time our entry/exit pricewise and make some money).

The gaming/fooling oneself happens as we can get sucked into a very good sounding narrative, where it appears that everyone is making money, the theory is very difficult to dismiss, and it is foolish to sit on the sidelines seeing people get richer .. every day, every week, every month …

Wisdom I guess lies in avoiding mistakes, knowing that we don’t know and appreciating evolution/chance/randomness.